Using Cost Information to Make Special Decisions

Chapter 9

Learning Objectives

• Define fixed and variable costs

• Compute price, fixed cost, variable cost per unit, or quality given to others

• Construct and interpret a break even chart

• Apply the concepts of contribution margin and product margin

Special Decisions• They are made on an as needed basis as opposed to a standard

schedule

• Nonfinancial criteria may outweigh financial criteria

• Tools help make these decisions

• Break even analysis

• Role of fixed and variable costs

• Break even chart

• Contribution Margin

• Product Margin

Break Even Analysis

• Also called Cost-Volume-Profit (CVP) analysis

• Studies relationships

• Approach can determine price, charges, and reimbursement

• Formula to determine total revenues

• Total revenue=Price x Quantity

Role of Fixed Costs

• The average fixed cost per visit is inversely related to volume as long as total fixed cost remains constant

• Caution when using this for decisions major errors

• Assuming that cost per unit does not change when volume changes

• Using fixed cost per unit derived at one level to forecast total fixed costs at another level

Role of Variable Costs

• 2 major characteristics

• Total variable costs change directly with a change in activity

• Variable cost per unit stays the same with a change in activity

• Formula Total variable costs=variable cost per unit x number of units per activity

Break Even Equation

• Price x Volume=Fixed Cost + Variable Cost

• Break even formula can be used to :

• Find Price

• Find quantity

• Find Fixed cost

• Find Variable cost per unit

Break Even Chart

• Graphically displays the relationships in the break even equation

• Break even point is the point where total revenues equal total costs

• Shortcut to calculating breakeven is Contribution Margin

• Total Contribution Margin=Total Revenue-Total Variable Cost

Product Margin

• Subtracting avoidable fixed cost from the total contribution margin yields product margin

• Multiple Services-organizational fixed costs and service specific fixed costs

• Avoidable fixed costs-a fixed cost that can be avoided if a service is not provided

• Nonavoidable fixed costs- A fixed cost that will remain even if a specific service is discontinued

Product Margin Used in Special Decision Making• Make or Buy Decisions- After comparing product margins, the

alternative with the higher product margin should be chosen

• Adding or Dropping a Service-If proposed service is expected to have a positive product margin it should be added, if lower drop

• Expanding or Reducing Service-Compare both product margins. Higher anticipated product margin should be chosen

Summary

• In order to make a decision regarding a service, a break even analysis can be used.

• Fixed and variable costs must be understood and used as a tool.

• Total contribution and product margins must be understood

• All contribute to the decision making process